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Exchange rates and monetary policy regimes in Canada and the U.S

  • Keith Sill
  • Jeffrey Wrase

This paper examines monetary regime switching in Canada and the United States and the implications of regime switching for exchange rates and key nominal and real macroeconomic aggregates for the two countries. Evidence of Markov regime switching in the process governing monetary base growth and in the bilateral exchange rate between the two countries is presented. Given this evidence, a two-country general equilibrium monetary model is constructed to account for observed properties of the U.S.-Canadian dollar exchange rate and for measured effects of monetary policy on key variables. Agents in the model face a monetary policy process with regime switching and form beliefs about regimes and money growth using observations and Bayesian learning. With the driving process for money growth rates parameterized using estimates from U.S. and Canadian data, quantitative implications of the model for behaviors of exchange rates and other key variables are examined. The findings are that inc lusion of learning by agents contributes somewhat to the model's ability to account for persistence in effects of money shocks on variables, provided that the shocks themselves are persistent; inclusion of learning contributes little in accounting for business cycle fluctuations and exchange rate variability; inclusion of a nonlinear driving process for money growth rates is important for the model to account for long swings in exchange rates; inclusion of learning adds only slightly to the ability of the model to account for long swings. The importance of nonlinearities in the driving process and the relative lack of importance of learning are consistent with other findings in the literature of learning effects in the face of regime switches.

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Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 99-13.

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Date of creation: 1999
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Handle: RePEc:fip:fedpwp:99-13
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  1. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March.
  2. Don E. Schlagenhauf & Jeffrey M. Wrase, 1992. "Liquidity and real activity in a simple open economy model," Discussion Paper / Institute for Empirical Macroeconomics 57, Federal Reserve Bank of Minneapolis.
  3. Maurice Obstfeld & Kenneth Rogoff, 1998. "Risk and Exchange Rates," NBER Working Papers 6694, National Bureau of Economic Research, Inc.
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  10. Keith Sill & Jeffrey Wrase, 1999. "Solving and simulating a simple open-economy model with Markov-switching driving processes and rational learning," Working Papers 99-14, Federal Reserve Bank of Philadelphia.
  11. Obstfeld, Maurice & Rogoff, Kenneth S., 1995. "Exchange Rate Dynamics Redux," Scholarly Articles 12491026, Harvard University Department of Economics.
  12. Betts, Caroline & Devereux, Michael B., 2000. "Exchange rate dynamics in a model of pricing-to-market," Journal of International Economics, Elsevier, vol. 50(1), pages 215-244, February.
  13. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2000. "Sticky Price Models of the Business Cycle: Can the Contract Multiplier Solve the Persistence Problem?," Econometrica, Econometric Society, vol. 68(5), pages 1151-1180, September.
  14. Stockman, Alan C., 1981. "Anticipated inflation and the capital stock in a cash in-advance economy," Journal of Monetary Economics, Elsevier, vol. 8(3), pages 387-393.
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  16. Lewis, Karen K., 1995. "Puzzles in international financial markets," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 37, pages 1913-1971 Elsevier.
  17. Martin Eichenbaum & Charles Evans, 1992. "Some empirical evidence on the effects of monetary policy shocks on exchange rates," Working Paper Series, Macroeconomic Issues 92-32, Federal Reserve Bank of Chicago.
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